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How regulators short-circuited the energy markets

How regulators short-circuited the energy markets

Energy Australia managing director Catherine Tanna got a few things right in her passionate address at The Australian Financial Review Energy Summit
last week.

Yes, the "entire electricity supply chain, including retailers, is culpable in a failure to provide affordable, reliable and cleaner energy". That
said, taking a "big stick" to the industry is not the answer.

It's also true it's not so much about building more capacity, as it is getting it all to work together seamlessly, finding the right balance between
intermittent renewable generation and traditional dispatchable power. Alas, her suggested fixes are underwhelming. If the head of Energy Australia
really wants to give people in the industry a sense of purpose and pride, she needs to reflect some more on its history.

Prior to the mid-1990s, generators and networks were managed as integrated monopolies, with all operational and investment trade-offs resolved centrally.
There was no retail function, as the vast majority of users were on fixed tariffs.

National Competition Policy reconfigured the industry, creating a wholesale market for competing generators and retailers, while separating out the
natural monopoly networks. Contrary to the Hilmer inquiry, which favoured a light-handed, negotiate-arbitrate model, transmission and distribution
were subjected to extensive economic regulation, a pragmatic decision, given their latent potential to derail the reform process.

As a consequence, however, wholesale market participants did not develop a working relationship with those businesses responsible for the cost-effective
transport of their product. The crucial interface was, in effect, contracted out to third-party regulators.

While initially successful, the risks associated with relying on well-meaning bureaucrats to second guess efficient infrastructure provision, eventually
came home to roost. Thanks to prescriptive distribution reliability standards in NSW and Queensland, and incorrect demand forecasts from the Australian
Energy Regulator, network charges became decoupled from market reality. And consumers paid the price.

Since then, the need for a truly integrated National Electricity Market has become more essential, just as the task of the AER has become more impossible.

A proliferation of distributed energy resources, such as small solar PV, combined with improved battery storage, has empowered consumers, giving rise
to two key issues.

Bespoke requirements

First, the traditional supply chain as a whole must now offer a competitive and highly tailored product. Consumers have bespoke requirements and a
variable willingness to pay. If this is not understood and responded to, consumers will tend to be even more self-sufficient.

Second, as Tanna notes, surplus energy coming back onto the grid from households is presenting a number of localised engineering challenges. The NEM
was not designed for two-way power flows.

Such technological disruption demands all members of the supply chain – not just different categories of generation – work together within a streamline
economic framework, based on best endeavours and good faith. This is the only way to secure the flexibility required to resolve increasingly complex
and subtle trade-offs and inter-dependencies, both technical and commercial. There is no reason, in principle, why generators, networks and retailers
cannot capture the integration benefits of the pre-NCP era while retaining competitive pressures.

But this is not happening, as evidenced by the recent co-ordination problems with the transition of metering responsibilities from distributors to
the retail sector.

And it's not happening because the existing institutions, the legal and consulting fraternity, and indeed the industry itself, want to go on believing
rules and centralised power can deliver the right results. Radical change is too threatening, even when the status quo is known to be untenable.

Sounds reasonable, except current NEM governance, overbearing and unduly formal, isn't designed to promote goodwill or a shared purpose. In fact, the
vast regulatory regime at its heart is premised on mistrust. Consumers will continue to be disappointed while networks are required to comply with
the views of a third party, rather than negotiate directly with other parts of the supply chain.

Energy is a three-legged stool, as Tanna suggests. But 20 years' after the NEM was created, it's time for government to finally leave the affordable
and reliable legs to industry, and focus on cleaner energy.

For this to happen, the practical implications of the massive disruption experienced by industry must be properly reflected in the institutional arrangements.
The supply chain cannot be efficient and responsive if the market operator, rule-making and rule-enforcing agencies do not also have skin in the
game.